Op-Ed: Office Market Hasn’t Bottomed Out Yet

Much has been written lately about the resurgence of the city’s office space market. Has the market really recovered?

Last year, financial markets were in a state of disarray not seen since the Great Depression. There was a sense that the U.S. banking system could actually collapse, dragging many businesses along with it. The sense of fear was palpable. Thankfully, lawmakers took decisive action, and a real crisis was averted. During this period, companies were not making capital intensive commitments such as leasing office space unless it was absolutely necessary. Previous market cycles demonstrated that while rents were quick to rise, they took a long time to drop. No one wanted to lease space only to have the market drop further; then they’d look foolish. Leasing activity ground to a halt.

By spring, it began to appear that the worst was over. Landlords had reacted more quickly to the declining market than in any previous cycle, and effective rents were roughly half of their peak. Tenants with compelling reasons for leasing that had delayed decisions finally felt they could move forward, and they snapped up great deals. Leasing activity rose significantly.

This increase in activity has led many to conclude that the worst is over, the market has recovered and that in some instances rents have begun to rise. Others point to the fact that more leases will be expiring in the coming months than is typical, which will drive demand and perhaps cause competition for some space.

Has the market actually reached bottom? The relevant data does not support that conclusion. The main driver for leasing activity is employment. New York City has lost almost 80,000 jobs, and, while the pace of layoffs has moderated, layoffs continue. A recent Rutgers University report predicts that U.S. employment will not recover to 2007 levels for seven years. While that may be overly pessimistic, it will be some time before businesses begin to hire in earnest because they have learned to do more with less and are reluctant to hire until improvements in their business necessitate it. Some have begun outsourcing service jobs to lower-cost countries.

In addition, more space continues to come onto the market than is being leased, yielding negative net absorption. Finally, many building owners and leasing agents have recently seen activity subside. Perhaps the pent-up demand following the period of fear has been met? Collectively, these factors do not seem to be a recipe for a recovery. It will be some time before equilibrium will be established, much less a recovery.

IF A BOTTOM HAS NOT yet been reached, what should the various stakeholders be doing?

State and local government should do everything possible to stimulate job growth. They also need to get their fiscal houses in order, because current rates of spending are unsustainable. Businesses will leave New York if taxes increase to cover wasteful spending. They should also extend existing leasing incentive programs and implement new ones until employment fully recovers.

To lease space, landlords must recognize that companies remain capital-constrained, and so they should pay for tenant’s construction costs.

Tenants should know that while the current market offers unique opportunities, there is no pressure to act. That said, while it is tempting to try to time the very bottom of the market to capture maximum value, it is ultimately a dangerous and counterproductive game. It is currently possible to capture 95 percent of the market correction. Trying to capture the last 5 percent is not the point. There are opportunities available to trade up to better space at lower rents and to lock in those low rents for the long term. It is also important to recognize that there are some pockets of strength in the market, and recently there have been bidding wars for better spaces in better buildings. It takes only two parties to create an auction, and it’s easy to get burned in such a situation.

So what are savvy tenants doing? They are engaged in the market now, performing their due diligence so that when their business improves and a fantastic opportunity presents itself, they are educated enough to be able to move quickly to capitalize on it. The worst is indeed over, and smart tenants no longer need to defer decisions.

William C. Montana is managing director at Studley and chairman of REBNY’s Commercial Board of Directors.